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Foreign Trust and Tax Implications

Foreign Trust and Tax Implications

Old May 15th 2023, 2:53 pm
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Default Foreign Trust and Tax Implications

Hi all,

My Mum is thinking about placing 25% of her estate in trust to me, and 25% to my daughter. She lives in the UK, myself and daughter live in the US (both citizens) and will do for the foreseeable.

If a foreign trust is set up in our names, what are the tax implications and or reporting requirements? Baring in mind, my daughter is <5 so will have no access to trust until 18, I will have signatory authority over it all (I think).

As long as this falls withing FATCA/FBAR etc, I have experience, but, wondering if there are any pitfalls I havnt considered.

We dont need the money, but my Mum doesnt want the government getting any more than they need to.

Cheers
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Old May 15th 2023, 3:02 pm
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Default Re: Foreign Trust and Tax Implications

I don’t know the answer except that it will probably need reporting every year as part of your IRS return on form 3520. Hopefully someone will come along with specific experience or knowledge on the topic.

https://www.irs.gov/businesses/inter...x-consequences

Information Reporting

Form 3520

In general, a Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts is required to be filed when a U.S. person:
  • creates or transfers money or property to a foreign trust or makes a loan to a foreign trust;
  • receives distributions from a foreign trust, receives the uncompensated use of property of a foreign trust, or receives a loan from a foreign trust;
  • is treated as the U.S. owner of a foreign trust under the grantor trust rules; and
  • receives certain large gifts or bequests from foreign persons.
The instructions for Form 3520 include more information about:
  1. who must file a Form 3520;
  2. when and where the Form 3520 must be filed; and
  3. possible penalties for filing the Form 3520 late or filing incomplete or inaccurate information.

Last edited by durham_lad; May 15th 2023 at 3:42 pm.
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Old May 15th 2023, 3:04 pm
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Default Re: Foreign Trust and Tax Implications

Originally Posted by durham_lad
I don’t know the answer except that it will probably need reporting every year as part of your IRS return on form 3250. Hopefully someone will come along with specific experience or knowledge on the topic.

https://www.irs.gov/businesses/inter...x-consequences

Thank you sir, I am headed in that same direction, specifically bullet point 3.

Any other experience from people on here is appreciated!
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Old May 15th 2023, 3:47 pm
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Default Re: Foreign Trust and Tax Implications

If you or your daughter own the trust (or part of it) then you will have to complete Form 3520 every year. If your mother owns the trust (assuming she is not a US person) and you and your daughter are only beneficiaries with no distributions until her death then you would only need to complete Form 3520 upon death and distribution of the assets. If the inherited assets exceed $100,000 then you will have to complete Form 3520 when the assets are distributed regardless of trust status. It would be a lot simpler for you if you are simply a beneficiary of the trust versus owning it, but perhaps that is what you meant. Form 3520 is complex and not a lot of fun to complete, with very stiff penalties for getting it wrong.
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Old May 15th 2023, 4:14 pm
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Default Re: Foreign Trust and Tax Implications

Originally Posted by Glasgow Girl
If you or your daughter own the trust (or part of it) then you will have to complete Form 3520 every year. If your mother owns the trust (assuming she is not a US person) and you and your daughter are only beneficiaries with no distributions until her death then you would only need to complete Form 3520 upon death and distribution of the assets. If the inherited assets exceed $100,000 then you will have to complete Form 3520 when the assets are distributed regardless of trust status. It would be a lot simpler for you if you are simply a beneficiary of the trust versus owning it, but perhaps that is what you meant. Form 3520 is complex and not a lot of fun to complete, with very stiff penalties for getting it wrong.
Aha, good point, I def only want us to be beneficiaries, in no way or form do I want to be an owner!
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Old May 15th 2023, 9:53 pm
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Default Re: Foreign Trust and Tax Implications

I really have no idea how viable this idea would be, but have you considered suggesting your mother setting up a trust in the US, instead of the UK?
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Old May 16th 2023, 1:27 am
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Default Re: Foreign Trust and Tax Implications

A non U.S. person can set up a trust in the US but as with everything there are pros and cons to international tax issues. The right course of action will depend upon the value of the trust, the asset mix, who controls it, whether it is revocable or irrevocable; and the the goals of the trust such as avoiding probate, inheritance tax, finding the most tax efficient way to transfer assets and manage income. One goal could conflict with another.

I am not a tax professional or financial advisor and could be mistaken or out of date in what follows so anyone who knows better please chime in. In any case here is how I broadly understand the situation, simplified because it is very complex and one of the few situations where I think consulting an international tax attorney is money well spent if there is a substantial estate.

The usual reason for setting up a trust is avoiding UK inheritance tax but to do that the trust needs to be irrevocable, be held for 7 years prior to death, and the trustee loses all ownership and control of the trust assets for ever.

With a revocable trust in most cases UK IHT is due at 20% rather than the non trust rates of 45%, but the trust owner retains ownership and control of the trust assets. However there are also trust entry and exit taxes for this type of trust and a recurring 10 year valuation tax. It all comes down to how much control and ownership the trustee is willing to give up versus the inheritance tax savings.

A non US person can set up a US based trust in the US as a revocable, or irrevocable domestic trust in which case it will be subject to US laws exclusively and must be controlled by a U.S. person. A non US person can also set up a revocable or irrevocable trust in a foreign country, which in the USA would be considered to be a revocable foreign grantor trust, or an irrevocable foreign non grantor trust, both of which are trusts governed by the laws of the country in which the trust is set up. A normal trust set up in a foreign country such as the UK would qualify as a foreign trust in the U.S.. A non US person, such as a UK parent may be uncomfortable transferring all control and laws to the USA so a US domestic trust may not be a great idea and a UK based trust is likely the better option.

I believe the same points below regarding a revocable/irrevocable foreign trust also apply to a revocable/irrevocable US domestic trust.

A revocable foreign trust will qualify as a foreign grantor trust which (in general) means that any distributions are tax free to the US beneficiary although the trust owner still has to pay tax to the IRS on all income associated with US assets and to their their country on all assets per those laws. However, after death of the trust owner, the trust will revert to an irrevocable foreign trust and any undistributed income will be subject to very unfavorable IRS tax rates. Selecting a revocable trust would result in UK inheritance tax at 20% plus the entry, exit and 10 yearly valuation tax.

An irrevocable foreign trust will qualify as a foreign non grantor trust which means that all distributions of all kinds subject the beneficiary to normal IRS taxation on all assets which I think, would make the choice of investment vehicle a major consideration in order to avoid punitive PFIC taxation and reporting. Although income and capital gains tax and PFIC taxation could be avoided if they remain undistributed, upon the death of the trust owner any undistributed income is subject to very unfavorable IRS tax rates, although I believe capital gains and income received after death are subject to normal IRS capital gains rates (and PFIC taxation). Selecting an irrevocable trust should attain zero UK inheritance tax.

In all cases property will get the stepped up basis, but democratic governments have a goal to remove that benefit so watch out for that in the future. Like I said it is very complex and a real minefield. Foreign US trusts have onerous reporting requirements and stiff penalties for getting it wrong or not reporting, so that also need to be taken into account as are the costs for setting up and maintaining the trust. Personally, I would stick with a UK trust for many, many reasons but unless advantages are significant I might avoid being the beneficiary of a trust altogether.

EDIT: Clarified that a UK based trust is a foreign grantor or non grantor trust. A foreign trust only subjects US persons to IRS taxes, non U.S. persons are only subject to the taxes in the trust home country (and whatever country they live in) and so work well for beneficiaries in different countries. Also clarified wording to make it easier to understand.

Last edited by Glasgow Girl; May 16th 2023 at 2:55 am.
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Old May 17th 2023, 7:38 am
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Default Re: Foreign Trust and Tax Implications

Your mother will be using a lawyer. Assuming your mother knows she has beneficiaries who are US persons, you may wish to suggest she asks her lawyer to get a US legal opinion on the consequences of whatever structure is being recommended. If your mother agrees, she could share a copy of that legal advice with you.
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Old May 18th 2023, 12:53 am
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Default Re: Foreign Trust and Tax Implications

Glasgow girl, thank you for that immense review. Way way more in depth than I appreciated. I am out of town so my response here will be short.

In all honesty, since we are not desperate to for the estate to avoid inheritance (with the risk of all the crud mentioned above), it may well be best to leave well alone.

I will speak to her CPA and get feedback on getting legal council as well.

Thank you also, Cook. This is giving me a lot of food for thought.


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Old May 18th 2023, 7:18 am
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Default Re: Foreign Trust and Tax Implications

Originally Posted by PetrifiedExPat
Glasgow girl, thank you for that immense review. Way way more in depth than I appreciated. I am out of town so my response here will be short.

In all honesty, since we are not desperate to for the estate to avoid inheritance (with the risk of all the crud mentioned above), it may well be best to leave well alone.

I will speak to her CPA and get feedback on getting legal council as well.

Thank you also, Cook. This is giving me a lot of food for thought.
FWIW, I have looked into this issue of minimizing IHT when we die and here is what we have been doing.

To create a trust to avoid IHT it has to be irrevocable (ie irreversible) which means I think that once the money goes into the trust you lose control of it and it is essentially gone. We have 2 children, now in their 40s and we know that they are financially responsible so we have been gifting them money every year. Just like a trust the gifts are subject to the 7 year rule but no reporting to HMRC is required so I keep a spreadsheet of the gifts and once a year print it out and put a copy in with our wills to make it easier for whoever executes our will when we die. We have been doing this for 6 years now and have gifted about an eighth (12.5%) of our assets so far. Our income from pensions is more than we need. Our daughter does not need any extra money, but it has been great for our son who has bought a house, a car and is able to do projects on the house etc.
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Old Jan 22nd 2024, 1:04 am
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Default Re: Foreign Trust and Tax Implications

My mum (UK citizen - no US connections), who died last year, left a trust fund with me as one of the beneficiaries - (me = US permanent resident). I haven't had any distributions from the funds yet. My understanding is that I can use a deed of variance (or similar) to pass on the trust (or distributions from the trust) to my daughters (UK citizens/resident). Big question is whether this would also avoid any US tax issues/reporting requirements?
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